To Buy or Not To Buy
6. Shifters of the demand curve

The influence of income on demand

Price is not the only constraining influence on Maria's choice, of course. The big one is income. Remember that an income statement measures flows of money in and out, and a balance sheet records all stocks, both assets and liabilities. Maria's accounts currently look like this:

Maria's income statement for last month
Expenses Income
Gasoline and car repairs All income from her work, parents
Airfare to fly home
Tuition and books
Everything else she buys
Maria's balance sheet for last month
Assets Liabilities
Cash on hand Unpaid credit card balance
Checking account balance
Savings account balance

If her income rises, we say her "income constraint" becomes "looser." Loosening the constraint of income, like loosening the constraint of a belt, means more possibilities for the consumer. Think of it as a literal constraint of ropes: a poor consumer is tied hand and foot. A rich consumer has a long leash on her appetites. It's one reason that rich Americans accumulate such a lot of junk from bad purchases---they don't have to be selective, and American houses even of the poor are big by international standards. So attics and garages pile up with junk. But even a rich consumer has a constraint, namely, that large income. Even Bill Gates cannot literally "afford" to retire the American national debt or buy up the continent of Europe. Even Tom Hanks has to make a painful decision between buying a $10,000,000 yacht on the one hand or a mansion in Beverly Hills on the other.

Quantitatively speaking, higher income normally results in more consumption of a good. The leash is longer and more ground can be covered. Goods that are treated this way by consumers are called normal goods. It's a sensible term: they are goods that consumers will buy more of as their income goes up, which has to be true of most goods. Why? Because a doubled income has to be spent on something. If Maria's income doubles she will buy more gasoline. Gasoline is for her a normal good.

Most goods are normal goods. Another good that is not normal is called inferior: demand for an inferior good goes down instead of up when income goes up. The classic example is supposed to be potatoes in Ireland before the Famine of 1846 (a recent careful study of the facts contradicts this tired old example, by the way). The idea was that potatoes are poor-folk's food, and when the poor folks of Ireland became more prosperous they were supposed to have started taking their starch in fancy white bread rather than in potatoes. A better example is so-called "black" bread, that is, bread made from something other than bleached wheat flour - rye bread, for example. For centuries in Europe rye bread was looked down on as the bread of the poor. In the eighteenth and nineteenth centuries people actually did change to white bread when they became better off. White bread was a normal good; rye bread was an inferior good. ("Inferiority," note, has nothing to do with the good's moral or indeed nutritional value. Black bread is actually healthier.)

A normal good is a good or service people will buy more of as their income goes up.

An inferior good is a good or service people will buy less of as their income goes up.

So what happens to the demand curve when income rises? If the good is a normal one, the rise in income will shift the demand curve to the right. If Maria finishes school and gets a job she will have a higher current income, spending more on all goods that she views as normal, including gasoline (see Figure 5.8).

Figure 5.8 When buyers have more income, the demand for "normal goods" will rise

Gasoline is a normal good. That means Maria will buy more of it when her income goes up - at a given price. Consequently, her demand curve shifts to the right. With a higher income she would buy more gasoline at each price level.

For Maria the effect will be that she will purchase more gasoline, as well as more of most other things. Her demand curve, economists say, "slides out along the supply curve" she faces---the "supply curve" she faces as a single consumer is just the going price. Try it out using your pencil as the demand curve. Note what happens to price and quantity as the demand curve slides out.

Paul: I can follow what you're saying. But I don't agree with all of it. I think inferior goods are associated with morals. Or at least with manners, that is, bad taste. Think of the peer pressure that the organic food-eating well-to-do will put on each other. We have wealthy friends in London. If I showed up to a dinner party in Chelsea with a can of "processed meat product" (Spam) and a box of do-it-yourself "velvety" nachos I would be hanged on Tower Bridge.

Ziliak: I see your point. To take another example, veganism is, at current prices in the United States, pretty much for rich people, or for people with a lot of time on their hands for food preparation, or both. The moral element you point out comes to the surface when the vegan's income radically falls; at the lower income he deliberates about the ethics of becoming a mere vegetarian (ingesting dairy and eggs and the like) or even a meat eater. To vegans, dairy and meat are inferior goods, neoclassically and morally speaking. It can be difficult to disentangle the income effect from the moral effect.

The influence of other prices on demand

Maria's income statement shows that other factors may influence her demand for gasoline. For example, during school holidays she could drive her car or take an airplane (note in her income statement the item "airfare"). Air travel is a substitute for automotive gasoline, as in Chapter 4 above, though not perfectly so.

Absolutely perfect substitutes would be one copy of today's newspaper and another copy of the same edition sitting beside it. If someone raised the price on one such copy, the demand curve for the other would obviously move outward dramatically, because no one cares which copy he or she gets.

Look at the item "car repair" in her budget. If the price of that goes up, then Maria will buy less gasoline, not more. Car repairing is a complement to gasoline consumption: Chapter 4 strikes again.

Notice that we speak of changes of prices relative to other prices. A 10 percent increase in the price of air fares or car repairing would not make a difference if the price of gasoline went up by 10 percent as well. Be warned. Do not think in mere dollar terms. Think in terms of relative prices, that is, the price of one good relative to other prices. Therefore general "inflation" of all prices has no effect on consumers, at any rate as consumers. (As speculators on foreign exchanges, or as holders of big dollar balances, it does.)

The influence of wealth on demand

And Maria's balance sheet affects her demand decisions as well. Remember from Chapter 2 that wealth is different from income. Wealth is what Maria owns on some date minus what she owes - her cash and checking account minus her credit card debt. Her income, by contrast, is not a stock (a snapshot) on a date but a flow between two dates - her wages from the 1st to the 31st of last month, say, or the monthly help she gets from her parents. A recent example of the effects of wealth on demand curves was the run up in the price of houses relative to other goods during the 1990s and 2000s. Your parents, or more likely your grandparents, who already owned a house, got a big gain in their wealth from the run up. They were tempted to spend some of this "paper wealth," and did so.

A person could have a low income but large wealth. In fact, most college students are such people. They are "poor" only so far as today's income is concerned. They can in fact look forward to a higher-than-average income, and they typically come from higher-than-average income families. So relative to what college students would consume at their income without the prospects of graduation and higher earnings ahead of them, their demand for many goods is pushed up. They can do so because they go into debt, with their parents or with the bank.

U.S. consumers after World War II

In 1946 right after World War II consumers were expected to be very---even excessively---careful with their income. Before the War the had been, and by being so careful had contributed to the Great Depression. But the carefulness didn't re-emerge. In fact people spent like drunken sailors, and for the same reason as drunken sailors: they had money in their pockets (so to speak), which they had saved up during the rationing of the War years. Their assets had been built up, which built up their demand curves for housing, cars, college educations, shopping malls, and all manner of things. The entire character of the society was changed by this wealth effect, resulting in explosive growth of suburbs, for example.

The upshot was one of the biggest errors ever in prediction by economists. Economists were very worried during the War that after it the Great Depression would start up again. Economists on all sides thought that consumers were inclined to "underconsumption"---too much saving. Capitalism was doomed unless government stepped in vigorously to make up the difference. Nope.

The influence of the future on demand

The balance sheet brings a hint of the future into Maria's decision. Incurring more debt is fine but she has to judge her ability to pay back in the future. In other words she has to form expectations on her future income next month and quite possibly beyond that. If she expects that future income to go up, her current demand for gasoline may go up a little. That is, her demand curve will shift a little outward to the right.

Maria may also foresee changes in future prices. If she expects the price of gasoline to go down from a temporary surplus in a week or so, she may decide to wait to buy the third or fourth gallon. That means a lower demand by Maria for chocolate gallons today, and a shift of the demand curve to the left.